Around half our stocks rose, but among the fallers was Adacel Technologies (ASX: ADA), which fell 13.3%. The company released guidance at its AGM that was less than what the market had hoped, while also disclosing that it has lost a contract awarded by the US Federal Aviation Authority. The timing was unfortunate as it came after directors sold more than $14m in stock in September and October. However, despite the turbulence, we believe our investment case remains on track and continue to hold Adacel in the fund.

Since inception in 1 Feb 17, the fund has returned 25.0% compared to 19.2% for the index.

Austin Engineering

Of course price movements over periods as short as a month mean little, if anything. Instead, we plan to use these updates to report on one or more of the fund's holdings. This month we look at Austin Engineering (ASX: ANG).

Austin designs and manufactures trays and buckets for dump trucks and front-end loaders, respectively, used by miners. It has operations on both the west and east coasts of Australia, in North America (where it operates under the WesTech brand), South America and in Indonesia.

The company competes against original equipment manufacturers (OEMs) including Caterpillar, Hitachi and Liebherr and is the largest of the non-OEM suppliers.

Austin also has an on-site and off-site repairs and maintenance division.

Table 1: Performance summary

Period to 30 Nov 2017

1m
(%)

3m
(%)

6m
(%)

Since
incep.
(%)*

Australian Small Companies Fund

-0.4

6.5

13.4

25.0

S&P/ASX Small Ordinaries Acc. Index

3.9

11.6

17.3

19.2

* 1 Feb 2017

**Performance is after fees and expenses

Austin works with miners to customise its designs based on the axle spread of the machine, its centre of gravity, the density of the commodity and the fragmentation of the rocks containing the valuable minerals. Its customised – and patented – designs increase miners’ productivity while lowering their costs (here is an example of trays or ‘beds’ Austin designed to increase productivity at Rio Tinto’s (ASX: RIO) Kennecott mine in Utah).

Combined with long-term customer relationships – which are often supported by ongoing repairs and maintenance activities on site – this increases the costs of switching to its competitors.

After conducting a debt-financed expansion spree over the past decade, Austin was hit hard by the mining downturn as miners severely curtailed their capital expenditure and postponed replacing their fleets.

However, multiple capital raisings allowed the company to survive (just) and finally get its debt under control.

It is now well placed to benefit from improving global economic growth and rising commodity prices, which are finally persuading miners to loosen their purse strings and start replacing their ageing fleets.

The company’s primary exposure is to iron ore, which supplies 31% of its revenue, closely followed by coal (30%) and then copper (19%) and counts some of the world’s biggest miners as customers.

While the high margins of the past – Austin achieved EBITDA margins of above 17% from 2011-2013 – probably wont be repeated, we expect the company to return to double-digit EBITDA margins in coming years.

This will be assisted by producing more products at its low-cost fabrication plant in Indonesia and also outsourcing the fabrication of its products to third-party manufacturers. The latter in particular means it is no longer limited by the capacity of its other factories.

And now that management can finally divert its attention away from just trying to survive, managing director Peter Forsyth is finding efficiencies by finally consolidating Austin’s far-flung operations. The various divisions have, until recently, almost functioned as separate companies rather than parts of an integrated whole.

The engineering, global marketing and business development functions have been centralised under common leadership, while potentially material savings could be achieved from the company consolidating its steel purchases (which are its biggest cost after labour).

Exposure to fluctuating steel prices is one risk but Austin has a partial natural hedge by purchasing steel in US dollars, the same currency in which its products are sold, while also having the option of passing on short-term fluctuations to its customers.

And while OEMs such as Hitachi and Liebherr principally use Austin’s products in their equipment, Caterpillar doesn't. Here, Peter Forsyth’s 27 years working for Caterpillar could come in handy, with the company also looking to improve its relationships with all OEMs and hopefully utilise their well-established distribution networks to expand sales of its products.

If all goes well, Austin could move from being the biggest non-OEM supplier of trays and buckets to the biggest supplier worldwide, OEMs included.

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